ECONOMICS OF PATENTS AND COMPULSORY LICENSING

 

by Shubham Janghu

In 2008, Bayer Corporation, a pharmaceutical firm, filed a patent for a drug ‘Sorafenib tosylate’ (market name- Nexavar), which was used for treatment of advanced liver and kidney cancer, for a period of 12 years. It gave treatment to patients at the cost of Rs. 2,80,000/-. NATCO communicated Bayer to ask for voluntary license to manufacture and sell their produce and to offer patients the medicine at Rs. 10,000/- per month of the treatment. But, Bayer refused to give such license. NATCO applied for compulsory license before the Controller, who granted them the same. Bayer appealed to IPAB, who upheld the Controller’s verdict.

Section 84(1) of the Indian Patent Act states that any person can apply for compulsory license after three years have expired from the date of grant of the patent to the patent-holder.

The court permitted the compulsory license due to following reasons-

  1. Bayer had failed to meet the reasonable requirements of public need (Section 84(1)(a)) with respect to the patented product. The court said that Nexavar was available to only 2% of all the patients. Bayer had failed to make the drug available.
  2. Nexavar was not available to the public at reasonably affordable price as it was priced at approximately Rs. 2,80,000/- as compared to Rs. 10,000/- offered by NATCO.
  3. Nexavar was not worked within the territory of India, even after 4 years from the date of grant of patent.

Modern economic theory has been skeptical about the intervention by the government. Neo-classical philosophers believe in free-market and do not desire any government intervention. They believe in the Adam Smith’s theory of ‘invisible hand’.

However, the ‘incentive paradigm’ makes an exception to such rule i.e. intellectual property to tackle the public good failure of a good. Pure public goods have two descriptions- non-excludability and non-rivalry. Non-excludability is when it is either impossible to remove the externalities or the cost to exclude the ‘free rider’ is very high. Free riding reduces incentives for financing innovation and without the interference of government; their supply is very small. Pharmaceutical industry invests an enormous amount of money in Research and Development (R&D). In absence of any patent, any other firm can easily copy it. It will only have to bear the production cost, which is almost negligible in comparison to the cost involved in R&D and sell the products at a price equal to the marginal cost. Non-rivalry is the characteristic that consumption of a good by one person does not necessarily stop others from getting the benefit from it. Using an idea, formula etc. does not prevent others from exploiting it. These characteristics support the practice of market intervention in order to incentivize the producer to do more research and create newer products.

However, by granting patents to one person, we are essentially giving him monopoly rights. He charged price greater than marginal cost, which leads to underproduction, and thus, deadweight loss. This lessens the social welfare. This necessitates balancing out the trade-offs.

It is argued that patents promote innovation by financing the production of knowledge, which does not come free of cost. Innovation is essentially risky. Deficiency of satisfactory return on investment will detract investment in risky and expensive ventures. Small quantity of investment will not be able to fund the R&D. Without such investment, individual innovators will not be able to start or spread their inventions. Reports like Tufts Centre for Study of Development Outlook (CSDD) said that the cost of developing new medicines in modern time is about 1.3 billion dollars. Hence, patents are helping in covering the cost of creation. Otherwise, any other person can blindly copy it and will bypass the whole process and cost of R&D.

Patents acts as an incentive to disclose information about their invention. Without a patent, an inventor might not just disclose the product or hide it in the final product. For instance, for many years, Coca Cola and KFC have not disclosed their recipes. They continued to further improve it without obtaining any patent. Patents act as a consideration between the society and the inventor. Sommer claims that insufficient protection of patents will induce the corporates to keep their inventions as trade secrets, which will give them an inequitable competitive edge and lead to reduction in welfare of society.

 

Nash Equilibrium also illustrates that patents do help to motivate the firms to develop newer products. The following table demonstrates the returns earned by a firm when it launched a new product –

 

                             FIRM B

FIRM A

INNOVATE NOT INNOVATE
INNOVATE 50,50 100,5
NOT INNOVATE 5, 100 10,10

 

The above table proves that firms will be compelled to innovate. Both Firm A and Firm B will invent to get best possible returns.

Assumptions, in this case, are that if a firm innovates, it will manufacture a new product, which will be entitled to a patent. However, if all firms decide to innovate, their products, although serving the identical objective, will be different and act as each other’s substitutes. Also, new products will also entice new customers to the market.

The dominant strategy for Firm A is to innovate. If Firm B decides to innovate, Firm A will either get 50 if it innovates or 5 if does not innovate. Logical choice will be to innovate. When Firm B decides not to innovate, the logical strategy for Firm A will be to innovate as it will obtain 100 as return as compared to 10 when it does not innovate.

Similarly, the dominant strategy for Firm B is to innovate. If Firm A opts to innovate, Firm B will also innovate as it gets better return (i.e. 50) in comparison to 5 when it decides not to innovate. If Firm A chooses not to innovate, it will either get 100 (when Firm B innovates) or 10 (when Firm B does not innovate).

Therefore, Nash Equilibrium is {INNOVATE, INNOVATE}.

When any one of the firm brings a new and better product in the market, it appeals to more customers, due to which, it gets more market share as new customers enter into the market and also it eats into its competitor’s market share. When all the firms choose to innovate, both the firms get bigger share than previously due to increased number of customers. Since, the products produced by the firms act as substitutes of each other, the market share gets divided.

The main disadvantage of patents in such cases is that the patent-holder gets monopoly rights over the product. This leads to selling of product way above the competitive price and under-production of the commodity. This gives rise to deadweight loss. It also gives birth to paradox of patents. For example, in pharmaceutical industry, health activists argue that life-saving drugs must be provided at the marginal cost; so more people can buy them. But on the other hand, the corporates say that protection from patents is needed to fuel more investment for better drugs.

The second drawback of patents is that it might excessive power over market and a way to reduce competition and concentrating control over production and dissemination of information. Acquiring a patent also require money requirements, which expels the minute inventors, who cannot meet these expenditures. Another criticism of patents is that the licensing cost of a patent is high. An injunction can be obtained on an unlicensed use. These costs hinder the successive innovations.

Some people believe that by giving a patent will stifle the next development over that product. If a creator has an exclusive right over a product, he will be having control over any further improvement. As a result, there will be lesser motivation to improve the product.

The third criticism of patents is that it takes the garb of incentivizing the inventor in order to earn monopoly profits. There are many insignificant inventions in the pharmaceutical industry. These medicines defeat the purposes of ‘modernized medicines’. Economic analysis is indifferent to the quality of the invention. It assumes that the new invention will be a ‘breakthrough’, which is not always the case.   

One of the solution to this problem is compulsory licensing. It is a legal instrument which forces the patent-holders to license their patents to a third part, which can produce at a lower cost. It creates a balance between the advantages and disadvantages of the problem. It guarantees that the patients get access to essential commodities like life-saving drugs. It also takes care of the interests of the innovator. Compulsory licensing can be obtained only after three years have elapsed from the date of grant of license. It lets the innovator to cover its sunk costs during that time-period. In addition to this, it also gets royalty from the licensee. Compulsory licensing helps to reduce the prices of the commodity which results in reduction of monopoly profits, deadweight loss and increase consumer surplus.

 

*Shubham Janghu, is a fourth year B.B.A. LL.B. student at O.P. Jindal Global University, Sonipat.

References:

Elkin-Koren, Niva. “The Law and Economics of Intellectual in the Digital Age”.            (2013) Routledge. 9th May 2015

Landes M. W. and Posner A.R. (2003), “The Economic Structure of Intellectual   Property Law, US: The Belknap Press of Harvard University Press. 10th May 2015

Sommer R.A. (2005), “Trouble of the Common: A Lockean Justification for Patent Law Harmonization”, Journal of the Patent and Trademark Office Society. 10th May 2015.

Fisher W.W. and Syed T. (2007), “Global Justice in Healthcare: Developing Drugs for the Developing World”, University of California, Davis. 10th May 2015.

Lemley A.M. (2005), “Property, Intellectual Property, and Free Riding”, Tex. L. Rev. 9th May 2015

Binhack M.D. (2006), “More or Better? Shaping the Public Domain”, in The Future of the Public Domain (P. Bernt Hugenholtz and Lucie Guibault, eds) UK: Kluwer Law International. 10th May 2015

Zaheer Abbas, Muhammad. “Pros and Cons of Compulsory Licensing: An Analysis of Arguments”(2013),  International Journal of Social Science and Humanity, Vol. 3, No. 3. 8th March 2015.

Fisher, William. “The Economics of Compulsory Licenses” January 25, 2013. Harvard Review. 10th May 2015

Featured Image:IP Draughts

 

 

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